Qualifying for a Mortgage: The 4 Factors Lenders Consider (and WHY!)

Preface: As most readers know I take a dim view on Guest Posts, however Sean Cooper is a friend of this site, and this content is topical.

Imagine this: after weeks and weeks of house hunting, you finally find the “one,” your dream home. You make and offer and it’s miraculously accepted. Congrats, you’re finally able to call yourself a homeowner! Well, almost. Unless you’re able to pay for your home in cash (can you adopt me?), you’ll have to take out a mortgage. If you’ve never applied for a mortgage before, you’re probably wondering how the process works (unfortunately, they don’t touch this stuff in school).

Let’s look at the four main factors lenders look at to qualify you for a mortgage and why.

1. Your Income

A mortgage is a lot of dough, even for banks. Lenders won’t just approve anyone for a mortgage. The banks are looking for someone earning a steady paycheque over at least the last couple years (someone who’s a salaried employee). If you’re a self-employed or contract employee, you’ll have a  lot tougher of a time qualifying for a mortgage. (Although a talented mortgage broker can help you find a lender well suited to you.) The reason for this is simple. The banks only want to lend to someone who will be able to afford to consistently pay their mortgage.

However, there are things you can do to help qualify for a bigger mortgage if you’re buying in a pricey real estate market like Toronto or Vancouver. By earning more income, you can qualify for a bigger mortgage and afford a more expensive home (all things considered equal).

If you aren’t able to qualify for the mortgage you were hoping, you might want to consider applying for a mortgage with a partner. It doesn’t have to be your romantic partner, it could be a brother, sister, aunt or uncle. If you have two incomes when applying for a mortgage, it will be a lot easier to get it approved to buy your dream home.

2. Your Down Payment

Similar to your income, the larger your down payment, the easier it will be to qualify for a mortgage. Ideally, we could all afford to make a 20 percent down payment, but that’s just not realistic, especially in cities like Toronto. Even putting 10 percent down can be challenging in pricey markets. Your down payment matters to lenders because they want to know that you have skin in the game.

If you’re unable to save up 20 percent towards your down payment, aim for a minimum of 10 percent. Besides, if you’re buying a home for under $1 million, you’ll be required to put at least 10 percent down on your portion of the sales price between $500,000 and $999,999. By putting more than 5 percent down, your mortgage will be smaller, helping you save on mortgage interest over the life of your mortgage.

But coming up with a larger down payment is easier said than done. How can you do this? By boosting your income or cutting back on expenses. To earn extra income, you could start your own business in your spare time. For example, if you’re skilled at photography, you could become a wedding photographer. Ways to save on expenses include carpooling and taking public transit more often and brown-bagging your lunch. If you could save yourself $50 a month extra, that’s more money you could put towards your down payment.

Click here to read 2 more important factors

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Credit Cards Help You Get a Mortgage

Do credit cards help you get a mortgage ? Most financial folks say having credit cards (which you pay off) are good to help build your credit score and thus help you get a mortgage. This is true, but far too often this idea is used as a sales pitch for credit cards.

Does  the Credit Limit on every credit card you have counts against you for your mortgage?

The person we dealt with at our bank did a credit check on us, when we applied for our mortgage and gave us a report that looked like this.

do credit cards help you get a mortgage

Shackled to Credit

http://www.ccpixs.com/

  • Credit Card 1 Balance $0  Credit Limit $1000
  • Store Credit Card 1 Balance $0  Credit Limit $2000
  • Credit Card 2 Balance $0  Credit Limit $2500
  • Store Credit Account 1  Balance $500  Credit Limit $5000  (we were buying a couch on a zero % interest deal)

We were then informed we had been OK’d for a mortgage balance of $X , taking into consideration my income, and our down payment. We were then informed that the real balance they would allow us to borrow would be lower.

$X - ( $1000 + $2000 + $2500 + $5000 )

The explanation given was the calculation done needed to include the potential debt load I might add with those extra debt vehicles. This made sense to me, and we got our Mortgage.

There are reports that this potential debt load is no longer being considered by some vendors? How could any sane lender not take this into consideration?

Question for Readers

Did your lender ask about credit cards, also did the credit cards count against your mortgage loan level ? I have had differing answers from different folks.

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Employee Discount Scam

Employee Discount, What Does it Mean?

I note one of the major banks is now offering Employee Rate Mortgages, attempting to entice you to move your mortgage over to their bank, with the promise of the same kind of discounts or lower rates that you would only receive if you were an employee of said bank. This continues on from the automobile manufacturers (specifically Ford) that offers Employee Rate discounts on their cars, but what kind of discount are you really getting?

RBC even touts these discounts when trying to entice new employees:

Whether you are looking to arrange a loan or buy a home, employee banking benefits can help you reach your financial goals. You’ll have access to valuable discounts on a wide range of banking, investment and insurance services, including reduced mortgage rates and reduced home and auto insurance rates.

These must be amazing discounts, and they are willing to give any person who walked in off the street the exact same “employee enticing” savings that they offer to their new hires ? That is amazing, but if they are giving you the same “insiders” rate that they give their own employees, weren’t those same folks taxed on that “benefit”?

Employee Discount

The Employee Discount Scam

No, this has little to do with the employees of RBC, and more to do with car financing marketing schemes from the Automobile industry. The Mortgage business is becoming quite cut-throat, so this is RBC attempting to differentiate themselves from their competitors by cloaking a better deal with the promise of it being an “insider’s deal” (thus assuredly the best deal you could possibly get).

What is next? I can see the marketing scheme already,

If you can find a better mortgage deal, you bring it to us and we will match that deal!

No, wait, that is precisely how the Mortgage business currently works.

Given our finance minister’s laissez faire attitude towards the banking industry lately, we may see more interesting “marketing schemes” introduced to entice us to move our hard earned cash to another banking institution.

Changing banks is fine, but make sure you get a good deal when you do it.

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Who Cares About Debt I Only Pay 2% on my Mortgage

That was the gist of a comment left on my post Let’s Define Debt Free (which you might have seen yesterday on my Twitter Feed).

Interesting point of view that I don’t agree with for a lot of reasons, but mostly because rates are not going to stay this low for that much longer, but even with that aside, I have never been a big fan of borrowing money to make money.

I lived through the dog days of the 90’s in the High Tech World, where our CEO attempted to rationalize how for every dollar that Nortel borrowed they made $3 back, it never really made a lot of sense to me at the time, and at the end of it, maybe I was correct in my assumption that this didn’t make any sense. I realize that most businesses do have to borrow to get on their feet, but to continuously borrow without paying off debt has always seemed rather fool-hardy to me.

Yes, I could have made a crass comment about how one "poke" from debt could deflate this balloon

Yes, I could have made a crass comment about how one “poke” from debt could deflate this balloon

Getting back to the statement of why should I pay off debt when I can make more money investing, depending on what you are investing in, how long do you think the gravy train will last? If you have a Mortgage at 4% that you are simply paying down as needed, but you are investing that extra money in the Market currently, you most likely are ahead of the game (i.e. making more than 4% back on investments), but are you sure that is going to last, and are you taking your profits?

This is my other concern, I had many colleagues and friends who were “on paper” millionaires, but never took their profits (and jumped to the wrong conclusions). Many folks did one of the following:

  • Never took out their profits, and they kept thinking that the bubble would keep growing (it didn’t).
  • Borrowed against perceived profits, using their stock as collateral for loans to either buy oversized houses or extravagant vacations, those loans were called when those stocks went bust.
  • Fiddled while Rome burned (i.e. didn’t get out because they kept thinking things would get better) (yes I was very guilty of that too).
  • Sold, took their profits, but then invested in even riskier stocks (remember Pets Inc., or Groceries to the Door?). Some of those risky stocks burned through cash and then just shuttered the windows.

These are some of the reasons I am paranoid about Debt (yes I said paranoid) and feel it is a much better “investment” to pay it down, than invest in anything else.

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The Principal is always Your Pal

Last week I wrote a very flawed post about What would Happen if Interest Rates doubled. Luckily my sharp-eyed commenters called me on it. Principal pay down is an important part of your debt repayment plan.

First point, like in school the PrinciPAL in your Mortgage is your Pal, not principle, as I originally wrote it. Someone commented how would anyone take me seriously if I was unable to discern the difference, I pointed out as the “Clown Prince of Personal Finance” respect isn’t really that high on my list.

The other major blunder I made was in my spreadsheet. Let’s have a look at my first assertion from my mortgage table. What’s wrong here:

Payment Number Principal Interest Payment Principal Payment
1 $250,000.00 -$833.33 -$486.26
2 $249,513.74 -$831.71 -$485.31
3 $249,028.43 -$830.09 -$484.37

Take a look at the PrinciPAL payment column, somehow my weird calculations have the amount you pay down on the principal each payment, decreasing, which is just SO wrong (even wronger than saying Principle of your Mortgage (in my subtle opinion)). What was wrong with me? I don’t usually screw up that many things in one article (that often).

The mistake I made was relying on the Excel PPMT() function to figure this out, instead of doing a simple calculated version on the basis of the Interest payment from IPMT()

Principal Payment = Monthly Payment – Interest Portion
Principal Payment  = $ 1319.59 –  $ 831.71 = $487.88  (for Month 2) (it got Month 1 right)

So really what this should have looked like was:

Payment Number Principal Interest Payment Principal Payment
1 $250,000.00 -$833.33 -$486.26
2 $249,513.74 -$831.71 -$487.88
3 $249,025.86 -$830.09 -$489.51

Thus the table for the end of the 5 year term would look like:

56 $220,700.69 -$735.67 -$583.92
57 $220,116.76 -$733.72 -$585.87
58 $219,530.89 -$731.77 -$587.82
59 $218,943.07 -$729.81 -$589.78
60 $218,353.29 -$727.84 -$591.75

More importantly the overpayment option now looks much better too:

Payment Number Principal Interest Payment Principal
Payment
Overpayment
37 $231,433.88 -$771.45 -$548.15 -$610.00
38 $230,275.73 -$767.59 -$552.01 -$610.00
39 $229,113.73 -$763.71 -$555.88 -$610.00
40 $227,947.85 -$759.83 -$559.77 -$610.00
41 $226,778.08 -$755.93 -$563.67 -$610.00
42 $225,604.42 -$752.01 -$567.58 -$610.00
43 $224,426.84 -$748.09 -$571.50 -$610.00
44 $223,245.34 -$744.15 -$575.44 -$610.00
45 $222,059.90 -$740.20 -$579.39 -$610.00
46 $220,870.50 -$736.24 -$583.36 -$610.00
47 $219,677.15 -$732.26 -$587.33 -$610.00
48 $218,479.81 -$728.27 -$591.33 -$610.00
49 $217,278.49 -$724.26 -$595.33 -$610.00
50 $216,073.16 -$720.24 -$599.35 -$610.00
51 $214,863.81 -$716.21 -$603.38 -$610.00
52 $213,650.43 -$712.17 -$607.42 -$610.00
53 $212,433.00 -$708.11 -$611.48 -$610.00
54 $211,211.52 -$704.04 -$615.55 -$610.00
55 $209,985.97 -$699.95 -$619.64 -$610.00
56 $208,756.33 -$695.85 -$623.74 -$610.00
57 $207,522.59 -$691.74 -$627.85 -$610.00
58 $206,284.74 -$687.62 -$631.98 -$610.00
59 $205,042.77 -$683.48 -$636.12 -$610.00
60 $203,796.65 -$679.32 -$640.27 -$610.00

Remember, it’s OK to point out my mistakes, but don’t be a comment troll about it either. Thanks to Michael James for pointing out the folly of my arithmetic.

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